Our fund initiated 78 short stock positions since Q4 2009. The geographic locations of these shorts' operating headquarters (HQs) provided some interesting results (see map for geographic location of shorts).
We used our standard criteria of bloated valuations and nominal/no revenues (median EV/Rev multiples > 500x), heavy losses, weak balance sheets, and questionable business models. We stuck mainly to the tech sector, where we have the most expertise. Basically, these were low-quality public venture companies that were hyped to less-sophisticated retail investors.
Our universe was limited to U.K., Canada and U.S. listed stocks, the large majority being listed on the OTC Bulletin Board (OTCBB) and Pink Sheet exchanges. 65 of the stocks were headquartered in the U.S., 6 in Canada, 4 in China, and one each in India, Switzerland, and the U.K.
Quan Shorts HQ Locations
|FL (mainly Miami - Boca Ration area)||11|
|CA (mainly Orange County, San Diego & LA areas)||10|
|NY (mainly Long Island & NYC)||6|
|TX (mainly Houston area)||6|
Based on our sample of 78 companies, the Miami - Boca Raton area stands out as a bastion for investment scams, especially on a per capita basis. This should not be misinterpreted that all tech stocks in Southern Florida are of poor quality. Citrix Systems (NASDAQ:CTXS) is a stellar Ft. Lauderdale-based software company providing desktop virtualization and other features that enable cloud computing for enterprises. A small ecosystem is in place in Southeastern Florida, however, to spawn and promote lower-quality public venture.
Southern California, Long Island/NYC, and Houston have more than their fair share of questionable companies in our sample as well.
As the sample was tech-focused, we ignored the plethora of speculative mining and natural resource stocks that are based in Western Canada, and Vancouver in particular. For nine companies, we entered the operating HQs, instead of the reported shell HQs that were mainly used for legal domicile reasons.
In spite of the bull market, the median last twelve-month LTM performance of the 78-stock universe was -47% (creating a substantial profit on these short positions), with 59 decliners and 19 advancers. All major regions exhibited roughly similar dismal performances (the two largest Short regions are in the table below).
Shorted Stocks LTM Price Performance
|neg. result = positive rtn on short||qty||mdn %chg||advancers||decliners|
While I cannot provide the names of all 78 shorts, the list of Florida and California-based shorts are enclosed. Please note these important caveats before reviewing the table below:
- 62% of the 78 shorts have already been fully covered, and many of the remaining stocks have lost a lot of their value since our fund initiated those positions. Similarly, 11 of the 21 shorted stocks below have already been covered, and our fund is sitting on a sizable profit of four of the ten remaining shorts.
- Shorting these stocks comes with major risks, including high borrowing costs, and forced buy-ins at elevated prices.
- Quan's short returns could be higher (via price declines) or lower (via price increases) than indicated in the LTM change below, depending on when Quan initiated and covered the position.
- This article should supplement fundamental analysis on these short candidates. Shorting stocks solely by their geographic location is not rational. For fundamental analyses on shorts, please see several previous articles such as 6 Overvalued Short Candidates, which discusses some of the stocks mentioned below.
Shorted Stocks from Florida & California
|Shorted Stk||Ticker||Optg HQ||Price 3/27/12||LTM % change||Short Covered|
|5Barz International||OTCPK:BARZ||Mission Viejo, CA||$0.21||-86%||Yes|
|Aura Systems||AUSI.OB||El Segundo, CA||$0.57||-15%||No|
|CrowdGather||OTCPK:CRWG||Woodland Hills, CA||$0.29||-71%||Yes|
|Green Automotive||OTCPK:GACR||Newport Beach, CA||$0.59||+31%||No|
|Helix Wind||OTCPK:HLXW||Poway, CA||$0.0002||-78%||Yes|
|Location Based Tech.||OTCPK:LBAS||Irvine, CA||$0.30||+81%||No|
|Nextwave Wireless||OTC:WAVE||San Diego, CA||$0.15||-78%||No|
|Takedown Entertainment||TKDN.OB||Beverly Hills, CA||$0.02||N/A||Yes|
|VelaTel Global Comm.||OTCPK:VELA||San Diego, CA||$0.03||-85%||Yes|
|Zap||OTCPK:ZAAP||Santa Rosa, CA||$0.19||-76%||Yes|
|ADB International||OTCQB:ADBI||Miami, FL||$0.0042||-59%||Yes|
|Clenergen||OTCPK:CRGE||Coral Springs, FL||$0.07||-92%||Yes|
|Florida Gaming||OTC:FGMG||Miami, FL||$3.63||+7%||No|
|Ghost Technology||GHST.PK||Miami, FL||$0.04||-81%||Yes|
|H&H Imports (delisted)||HNHID||Plantation, FL||$0.00||N/A||Yes|
|Latitude Solutions||OTC:LATI||Boca Raton, FL||$1.36||-55%||No|
|Net Element||NETE||Miami, FL||$0.25||+150%||No|
|TherapeuticsMD||TXMD.OB||Boca Raton, FL||$2.49||N/A||No|
|XG Technology||XGTC.PK||Sarasota, FL||0.68||N/A||No|
The two leading venture-backed ecosystems - Silicon Valley and Boston had no companies on our black list. Austin, TX had one company - Valence Technology (VLNC), but this was an atypical selection. Valence has a decent lithium-ion battery technology with latest quarterly revenues in excess of $8M. But Valence has been a perpetual money-loser with a lot of debt, and a lithium-ion-battery electric- vehicle end-market that may be more narrow than initially expected.
While a larger sample size is needed to verify this preliminary analysis, one can reason that the lack of an established technology/venture capital ecosystem in certain regions, is a contributing factor for aspiring entrepreneurs in those areas to seek capital from listing on less-regulated US stock exchanges. The main problem with this public venture strategy is a time horizon mismatch. Public-market investors have a quarterly time horizon, while these businesses require a number of years to develop. Thus, the outcome is often disappointing results, dilutive financings, and constant fundraising that detracts senior management, eventually leading to a stock price collapse. In the interim, an ecosystem of stock promoters and insiders pump-up the share prices as much as possible on news flow. This creates the shorting opportunity. The motivations of insiders and promoters with their low-cost shares may not be altruistic (see here for more details).
Not all public venture and OTCBB stocks are bad. In fact, we own Procera Networks (NYSEMKT:PKT), which in 2003 took the public venture route of a reverse takeover into a shell that listed on the OTCBB. Procera later uplisted onto the AMEX and more recently onto the Nasdaq. Procera did not have the luxury of large VC capital investment, which forced it to be more efficient with its capital, albeit growing at a slower pace. A fortuitous acquisition of a Swedish company in 2007 strengthened Procera's Deep Packet Inspection (DPI) technology for telecom networks. A recent surge in demand for DPI and related policy enforcement of telecom network traffic, led to 108% y-o-y revenue growth in the latest reported quarter to $16M (see here for more details). But keep in mind, this was eight years after Procera's listing on the OTCBB. We even own one OTCBB microcap, George Risk Industries (OTCPK:RSKIA), a Nebraska-based manufacturer of home security equipment.
Furthermore, there has been increased discussion of Crowdsourcing to help alleviate the capital shortage for entrepreneurs in many U.S. regions. Crowdsourcing enables non-qualified investors (generally the bulk of Americans that are not millionaires) to invest in venture capital. This needs to be carefully planned so that mainstream investors understand that greater potential venture returns are accompanied by higher illiquidity and business risk. Speaking from experience from our venture funds era, individual investors risk appetites can change with market conditions. These Crowdsourcing exchange networks, however, may provide more liquidity for individual investors than what existed in past years.